Platinum and Gold

Platinum and gold, how much of a relationship do these metals really have?
Gold has been the talk of the town lately, a growingly-popular safe haven in
these wild economic times. But platinum, one hardly hears of this metal. Guys
like me who have wives with high-end jewelry taste certainly know about platinum,
and car buffs are familiar with its use in catalytic converters. But with the
average investor knowing very little about this metal, is it even on the same
playing field as gold?

Platinum and gold are definitely on the same playing field in that they are
both commodities in the midst of powerful secular bull markets undergirded
by strong long-term fundamentals. Platinum's bull gathered momentum around
the same time as gold's, in 2001, and had seen a 448% gain to its 2008
high.

Categorically these metals have a lot in common in that they are both very precious.
In fact, measured by price platinum is more precious than gold. With
it getting as high as $2273 in March 2008, and currently at about the $1500
level, it definitely costs more to buy an ounce. And with platinum's annual
production volume at about 6.0m ounces, about 8% that of gold's, it is more
rare.

Also like gold, platinum has many different applications. Autocatalysts and
jewelry are by far the largest demand components. But there are a whole slew
of other uses, from turbine blades to medical sensors. Platinum even has an
investment side to it via a growing market for coins, bars, and the new asset-backed
ETFs.

But from a trading perspective, do platinum traders really tune in to the
actions of the bellwether precious metal? The following charts will paint pictures
of how these two metals really do relate. And as you'll find, there
are indeed very compelling technical relationships.

In this first chart is platinum and gold's secular picture, and the similarities
sure are visually striking. As you can see, these metals had a very tight correlation
prior to the infamous stock panic of 2008. When gold rallied, platinum was
right there with it. And when gold pulled back, platinum followed suit. Not
only is this correlation visually apparent, but the math concurs. From 2002
to August 2008 platinum had an amazing correlation r-square of 95% with
gold!

This means 95% of the daily behavior of platinum's price could be explained
by the daily movement of gold. An incredibly tight correlation! Despite platinum's
own fundamental merits, this long-term correlation shows gold to be a very
strong technical driver of platinum. But thanks to the stock panic, this correlation
came to a screeching halt.

In those wretched late-2008 months when every asset was being sold off with
reckless abandon, platinum set a course for ruin and was oblivious to what
was happening with gold. During the panic the only correlation was the fact
that both metals were down. On a day-to-day basis, an r-square of 22% showed
these metals were dancing to different tunes.

From their all-time highs in the beginning of the year, platinum and gold
plummeted 66% and 29% respectively to their 2008 panic lows. Platinum was simply
obliterated, falling to prices not seen since 2003. But these outsized
losses compared to gold were not a complete surprise considering the nature
of platinum's market.

Since platinum trades in such a tiny market compared to most other commodities,
it doesn't take much outsized buying or selling pressure to quickly move its
price. And this allows sentiment to play a much larger role. With such an incredible
state of fear during the panic, traders aggressively unwound their platinum
positions, thus resulting in a high-velocity decline.

Finally after traders realized the world wasn't coming to an end in late 2008,
platinum found its panic bottom and quickly entered into recovery mode. And
it would have its work cut out for it to recover from such catastrophic losses.
Gold of course found its bottom around this same time, and platinum would look
back to the yellow metal to set its course. From the panic bottom to current,
these two metals have sported a correlation r-square of 85%.

But as is glaringly obvious in the chart above, gold has easily recovered
its panic losses and platinum has not. In September 2009 gold achieved a new
all-time record high, and has been trending higher ever since. Platinum has
had an excellent recovery of its own, more than doubling so far off its panic
lows. But it is nowhere near its highs from a couple years ago.

Platinum bulls are of course very concerned that this metal has not retested
its highs while gold has blown through its own. But I believe this is easily
explainable when you consider the utility of these metals. And it is simple
economics that tells the precious-metals story that has played out in recent
years.

With continued supply strain on the mining fronts for both platinum and gold,
it is the activities on the demand side of the economic scale that have of
course been the big price drivers. And as anyone with a pulse is fully aware,
the current global recession has radically altered the demand for virtually
all goods and services.

During recessionary times it is especially likely for demand to fade in such
areas as industrials. When consumption and development slows, manufacturers
produce fewer goods. And these same manufacturers tend to drain their inventories
during such times, lowering demand even farther. So naturally those metals
with higher industrial exposure are more likely to experience economic strain.
And this strain typically results in decelerating demand growth and/or falling
prices.

Gold has minimal industrial exposure, an average of only about 10% of its
demand in recent years, with investment and jewelry by far the largest demand
components. So with minimal economic pressure on the industrial side, a structural
supply deficit, and growing mainstream exposure on the investment front, this
metal easily warrants the price activity seen thus far.

When you consider platinum's sensitivity to the economy, this metal doesn't
feel quite as precious. Over the last 5 years an average of 66% of platinum's
annual usage has come from the industrial side of things. And with the largest
industrial-type demand coming from the automotive industry, this recession
has no doubt strained platinum. Much lower global vehicle production has led
to 2009 autocatalyst demand being nearly half what it was in 2007 according
to Johnson Matthey (JM).

This weak industrial demand put the platinum market into a surplus in 2009.
And if it wasn't for huge jewelry demand out of China (2.0m ounces), 2009's
surplus would have been much larger than the 285k ounces JM estimated. So did
platinum's price warrant a reversion to its highs like gold? Absolutely not!

But just because platinum's interim fundamentals are struggling along with
the economy, it doesn't mean its post-panic gains to date are a fluke and that
long-term fundamentals have been compromised. According to numbers provided
by JM, since 1999 platinum has run a 2.1m-ounce supply deficit, even
after the 2009 surplus. Platinum is also in the midst of a 3-year-running production
decline on the mining front.

If investment (helped by the emergence of asset-backed ETFs) and jewelry (China
is just starting to get a taste for this metal) demand continues to strengthen
while the economy continues its turnaround, platinum will quickly revert to
a deficit environment. And this will of course send prices much higher.

So where can we expect platinum prices to go once its interim fundamentals
stop holding it back? Let's again look to gold for some guidance. And in the
platinum/gold ratio we see a technical relationship that goes beyond correlation.
The PGR divides platinum's daily closing price by gold's daily closing price.
And the resulting data charted over time reveals a fascinating picture.

The PGR line in blue does a fine job expressing platinum's relationship with
gold in a single data series, showing where platinum tends to trade relative
to gold over time. When the PGR is rising, platinum is either outperforming
gold or declining at a slower pace. And when the PGR is falling, gold is either
outperforming platinum or declining at a slower pace. The resulting number
is how many ounces of gold it takes to be equal in value to one ounce of platinum
at any point in time.

As you can see in this chart, up until the panic platinum had a well-defined
secular relationship with gold. For 6 years the PGR resided within a
horizontal trading range, from about 1.75x on the low side to 2.10x on the
high side. When platinum traders got excited the PGR would approach the high
side of this range, on two occurrences vaulting the PGR well above resistance.
And when traders showed fear the PGR would slide towards support, with 1.75x
holding very strong. Over this 6-year span the PGR averaged 1.95x. This means
that during the lion's share of platinum's bull leading up to the panic, it
would cost two ounces of gold to buy one ounce of platinum.

Towards the end of these 6 years of normalcy, in the first half of 2008, the
precious metals would see huge rallies, and platinum traders really got excited.
In this tiny market it doesn't take much differential buying pressure to bid
this metal up real fast. And with a PGR above 2.30x, platinum was well-outperforming
gold.

But right away in the second half of 2008 platinum followed the entire commodities
complex into a much-needed correction. And just as easily as platinum outperformed
gold on the upside, as you can see by the PGR's sharp decline platinum's losses
outpaced gold's on the downside. And with the panic accelerating this correction,
buyers of platinum became difficult to find.

By early September the PGR had decisively knifed through support, and continued
to plunge until it bottomed at 0.97 in December. With platinum's loss
at over twice that of gold's (-66% versus -29%), it is easy to see how the
PGR could be sliced in half. But even though this metal had more of a fundamental
reason to fall harder than gold, it was radically oversold. And at this bottom
traders could hardly believe platinum was trading at par with gold!

A PGR at or below 1.00 would have seemed simply unheard of just a few months
before it actually happened. Platinum trading at or under the price of gold
has been an extremely rare occurrence in recent decades. In fact, the last
time it actually happened was 12 years prior, in late 1996. And this was only
for a very brief spell. Platinum had not decisively been below gold
for nearly 25 years. Over these last 25 years less than 2% of trading
days had seen platinum lower than gold, each instance only marginally.

This super-low PGR of 0.97 had not been seen since January 1992, showing
just how ridiculously oversold platinum was. But it didn't take long for traders
to recognize this anomaly, and going into 2009 platinum mounted a powerful
rally. To its high in April platinum gained 128%, well outpacing gold's 58%
gain over this period. And as you can see, this outsized gain has led to an
uptrending PGR over the last year and a half or so.

But even with the PGR heading in the right direction, it still has a long
way to go before it gets back to its pre-panic secular trading range. Just
to get to the 6-year average platinum would need to climb to about $2300 at
today's gold price, which would be a new all-time high. And of course if gold
rises from today's levels, platinum's price would need to be even higher in
order to return to a 1.95x PGR.

So what does this still-low PGR, well under 1.50x, tell us about platinum's
future? Well if the PGR returns to normalcy, platinum must continue to outperform
gold on balance. And I do believe this is possible considering platinum's speculative
nature, which historically shows this metal having positive leverage to gold
when traders get excited.

But in order for this to happen platinum needs fundamental support. And based
on what we know about the state of the platinum market, this support may not
be too far away. The fundamentals are currently falling back in line, and it
won't take much of a demand boost for this metal's balance to revert back to
a deficit.

If this happens the PGR should continue to be a reliable tool even in this
post-panic environment. In isolation the PGR means nothing, but we can't discount
6 years' worth of such a telling relationship between platinum and gold. Over
such a long span a lot of random noise is filtered out, which makes it more
likely that this relationship actually has underlying fundamental support.

Now does this mean the PGR deserves to be in that pre-panic range today? Probably
not. It will take time for platinum to recover from this recession. But you
know what, more and more cars will be built, platinum jewelry demand still
has a lot of upside, and investment in this precious metal is just getting
rolling. The PGR's return to normalcy won't take much time once platinum traders
get excited again.

And platinum traders won't be the only ones profiting from this metal's resurgence.
The miners pulling this metal from the ground are in line for huge profits
as its price continues to rise. In our acclaimed weekly and monthly newsletters
we recently recommended an elite platinum stock that will greatly benefit as
the PGR continues its grind upwards. Subscribe
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The bottom line is platinum and gold have a relationship that goes beyond
the preciousness of these metals. And while platinum will ultimately live and
die by its own fundamental merits, what happens in the gold markets has shown
to color this metal's sentiment, and thus price. Gold is the bellwether precious
metal, so it will naturally have an influence on its peer group.

This influence on the upside usually leads to platinum outperforming gold.
And this is exactly what's played out since the panic bottom. But as the PGR
reveals, platinum still has a lot of catching up to do if it is to return to
its pre-panic secular trading range. If the PGR continues to trend higher,
which it should based on platinum's bullish secular outlook, much higher platinum
prices are in store.

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that details exactly what we are doing in terms of actual stock and options
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Thoughts, comments, or flames? Fire away at scottq@zealllc.com.
Depending on the volume of feedback I may not have time to respond personally,
but I will read all messages. Thanks!